Getting up to speed on blockchain, Bitcoin, Ethereum, cryptocurrencies and ICOs

Much has been written recently on blockchain, Bitcoin, Ethereum, cryptocurrencies and initial coin offerings (ICO). Unfortunately, for non-computer scientists (like me), trying to understand these concepts and their potential implications can be a bit overwhelming. To help all of those non-technologists trying to get their heads around blockchain, Bitcoin, Ethereum, cryptocurrencies and ICOs, I pulled together the following list of resources that I have found useful. As an attorney who represents startup and emerging growth companies, it seems likely that these technologies will prove to be disruptive to how we do business, build new technology, fund startups and even think about employment – much like the initial proliferation of the Internet. Let’s start with a brief overview of these technologies and how they relate to each other.

By this point everyone has probably heard of Bitcoin, the digital currency and first widely publicized application of blockchain technology. Bitcoin is not blockchain, but rather an application based on blockchain technology. Blockchain is a decentralized (peer-to-peer) network that allows connected computers to reach agreement (based on consensus) over shared data. In other words, blockchain is a ledger that creates a record of digital transactions that is open to, and updated by, the public. Here is how Wikipedia defines a blockchain:

“[A] distributed database that is used to maintain a continuously growing list of records, called blocks. Each block contains a timestamp and a link to a previous block. A blockchain is typically managed by a peer-to-peer network collectively adhering to a protocol for validating new blocks. By design, blockchains are inherently resistant to modification of the data. Once recorded, the data in any given block cannot be altered retroactively without the alteration of all subsequent blocks and the collusion of the network. Functionally, a blockchain can serve as ‘an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way. The ledger itself can also be programmed to trigger transactions automatically.’”

As Collin Thompson explains: “[h]istorically, when it comes to transacting money or anything of value, people and businesses have relied heavily on intermediaries like banks and governments to ensure trust and certainty. Middlemen perform a range of important tasks that help build trust into the transactional process like authentication & record keeping.” In other words, blockchain provides a way of conducting digital transactions without a third party intermediary.

So far, two of the most popular applications of this technology are Bitcoin and Ethereum. At the highest level, Ethereum is an open software platform using blockchain technology that enables developers to build and deploy decentralized applications. Blockgeeks describe the difference between Bitcoin and Ethereum as follows:

“Like Bitcoin, Ethereum is a distributed public blockchain network. Although there are some significant technical differences between the two, the most important distinction to note is that Bitcoin and Ethereum differ substantially in purpose and capability. Bitcoin offers one particular application of blockchain technology, a peer to peer electronic cash system that enables online Bitcoin payments. While the bitcoin blockchain is used to track ownership of digital currency (bitcoins), the Ethereum blockchain focuses on running the programming code of any decentralized application. In the Ethereum blockchain, instead of mining for bitcoin, miners work to earn Ether, a type of crypto token that fuels the network. Beyond a tradeable cryptocurrency, Ether is also used by application developers to pay for transaction fees and services on the Ethereum network.”

I thought Ben Thompson of Stratechery and Fred Ehrsam of Coinbase provided a great explanation of why all of this matters and the utility of blockchains:

“Ethereum is based on a blockchain, like Bitcoin, which means it has an attached currency (Ether) that incentivizes miners to verify transactions. However, the protocol includes smart contract functionality, which means that two untrusted parties can engage in a contract without a 3rd-party enforcement entity.

One of the biggest applications of this functionality is, unsurprisingly, other cryptocurrencies. The last year [2016] in particular has seen an explosion in Initial Coin Offerings (ICOs), usually on Ethereum. In an ICO a new blockchain-based entity is created, with the initial “tokens” — i.e. currency — being sold (for Ether or Bitcoin). These initial offerings are, at least in theory, valuable because the currency will, if the application built on the blockchain is successful, increase in value over time.

This has the potential to be particularly exciting for the creation of decentralized networks. Fred Ehrsam explained on the Coinbase blog:

‘Historically it has been difficult to incentivize the creation of new protocols as Albert Wenger points out. This has been because 1) there had been no direct way to monetize the creation and maintenance of these protocols and 2) it had been difficult to get a new protocol off the ground because of the chicken and the egg problem. For example, with SMTP, our email protocol, there was no direct monetary incentive to create the protocol — it was only later that businesses like Outlook, Hotmail, and Gmail started using it and made a real business on top of it. As a result we see very successful protocols and they tend to be quite old. (Editor: and created when the Internet was government-supported)

Now someone can create a protocol, create a token that is native to that protocol, and retain some of that token for themselves and for future development. This is a great way to incentivize creators: if the protocol is successful, the token will go up in value… In addition, tokens help solve the classic chicken and the egg problem that many networks have…the value of a network goes up a lot when more people join it. So how do you get people to join a brand new network? You give people partial ownership of the network. These two incentives are amazing offsets for each other. When the network is less populated and useful you now have a stronger incentive to join it.’”

Before you get to the list of resources, I thought I would say a few words about how all of this technology intersects with the law. For years, technology and innovation have outpaced law makers’ ability to keep up – a trend that inevitably will continue. In the last two decades this has been most apparent with governments’ inability to find good solutions to issues such as Internet tax and data privacy. The rise of blockchain clearly presents a whole host of new issues that current regulatory regimes are not set-up to address – many of which may be akin to those that regulators grapple with while trying to regulate shared economy businesses.

For example, how do you regulate an industry where there is no large intermediary to target? After years of trying to figure out the application of sales and use tax to Internet purchases and sales, the IRS’s primary target to enforce tax payment appears to be through the large e-commerce retailers. But what happens when there is no retailer intermediating e-commerce, or no Lyft intermediating ride sharing, or no bank intermediating online payment transactions? Some observers believe the ultimate answer will come from self-governance, which would obviously represent a fundamental shift in existing regulatory frameworks for businesses. Whatever the answer ends up being though, blockchain and the applications built upon it do not fit neatly within existing traditional legal frameworks, and regulators will need to balance the need to create laws that protect participants against the risks of chilling innovation. If law makers are not able to strike the appropriate balance, then companies and innovation will likely migrate to jurisdictions with less restrictive laws, which is already apparent in the Bitcoin space (where different states within the United States are taking different approaches as to whether Bitcoin-related companies are “money transmitters” under state law).

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The Venture Alley is a blog about business and legal issues important to entrepreneurs, startups, venture capitalists and angel investors. The Venture Alley is edited by Trent Dykes and Andrew Ledbetter, corporate and securities lawyers at DLA Piper.